401(k) and 403(b) Lawsuit Update

Since August 9th, lawsuits have been filed against nine different universities for various Employee Retirement Income Security Act (ERISA) claims. Columbia, Emory, MIT, NYU, Yale, Duke, Johns Hopkins, UPenn, and Vanderbilt now find themselves forced to defend the management of their 403(b) plans in court. Financial Institutions, religious organizations, and hospitals have also come under attack for excessive fees for 401(k) plans and underfunded defined benefit plans. Could you be next?

For about ten years, 401(k) litigation has been going on and now eager lawyers are extending it over to 403(b) plans. Most of the lawsuits focus primarily on the failure by plan sponsors and fiduciaries to establish and follow appropriate processes for overseeing plan fees and investments. The Federal statute of limitations on such claims is six years, so fiduciaries are held accountable for their actions (or lack thereof) back to 2010. State schools can breathe a sigh of relief since ERISA does not extend to governmental employers.

Common Claims in 403(b) and 401(k) Litigation

Most of the lawsuits being filed right now challenge fiduciary oversight of fees paid by plans and the process for selecting/retaining service providers, focusing on a number of specific practices:

  • Use of multiple record keepers: costly and (in effect) provide no value;
  • Failure to monitor and review fees paid to record keepers;
  • Failure to capture increased revenue sharing (attributable to asset growth) for the benefit of participants or plans;
  • Use of retail share classes when institutional share classes are available to these large plans;
  • Use of actively managed funds over indexed funds, without demonstrating that higher fees add commensurate value;
  • Use of multiple investment funds in same asset classes: reduces plan’s ability to negotiate favorable fees and makes plans confusing to participants;
  • Failure to eliminate certain “chronically underperforming” funds.
  • Best Practices to Mitigate Litigation

In order to avoid lawsuits, it is important to know what the law says about specific claims. Below we will focus on four claims, investigate what exactly ERISA says about them, and discuss different ways to protect yourself against litigation.

Claim #1: Using Multiple Record Keepers

The Claim: Institutions have faced claims that using multiple record keepers dilutes plan leverage and creates excessive recordkeeping fees, which drive up costs and is inherently confusing and inefficient.

What ERISA Says: ERISA does not directly address whether it is appropriate or not, but requires that selection and retention of record keepers be made under the “prudent man” rule. This rule states that you must act in the way that a prudent person who is an expert in such matters would act. Since the law doesn’t say anything explicitly, you have to ask yourself, “Can retention of multiple recordkeepers be justified under this rule?”

Best Practices: Since ERISA does not prevent an institution from having multiple record keepers, each institution must examine whether the use of multiple record keepers is justified in their particular situation. This analysis should include reviewing industry best practices, considering the cost (both direct and indirect) and services under a sole provider scenario, and comparing multiple versus single record keeper arrangements. A Request for Proposal (RFP) process might be appropriate to document the cost differential. If your institution chooses to utilize multiple record keepers, the decision process that spells out the benefits of using multiple record keepers should be well documented.

Claim #2: Maintaining Reasonable Recordkeeping Fees

The Claim: Having a greater prevalence in lawsuits, this claim is that the defendants failed to prudently monitor and control the compensation received by the plan’s record keepers to ensure that the plan only paid reasonable fees for recordkeeping and administrative services. Lawsuits suggest an RFP process every three years and also raise questions about the disconnect between revenue sharing (generated by asset growth) and cost of plan administration.

What ERISA Says: ERISA requires plans to monitor the fees paid to all service providers, ensuring that they are reasonable fees for the services provided. Plan fees should be benchmarked on a regular basis to ensure that they remain competitive compared to similar plans.

Best Practices: The determination of whether fees are reasonable first requires that the institution knows what the record keeper is charging in terms of record keeping (or administration) fees. Here at Beacon Pointe, we regularly engage in the following to determine the reasonableness of record keeping fees:

  • Comparison of the client’s revenue requirement to:
    • Similarly positioned clients (assets, participants, balance sizes);
    • BrightScope, Fiduciary Benchmarks, and other database fee sources;
    • Direct Request for Information (RFI) and RFP from alternative record keepers.
  • Negotiation of required revenue with the record keeper. Our research findings from the above comparison prove a useful tool in negotiations.
Claim #3: Offering appropriate funds and share classes

The Claim: Many lawsuits allege that the defendants failed to prudently consider or offer dramatically lower-cost investments that were available to the plans, including identical mutual funds in lower-cost share classes.

What ERISA Says: The law requires plan fiduciaries to follow the “prudent man” rule mentioned above, and to use funds with reasonable fees for the services provided.

Best Practices: For an institution to know that fees are reasonable for services rendered, it is imperative to be aware of all of the share classes available for a particular fund to a particular client. They also must regularly (we suggest annually) monitor the available share classes, given that over time, investment managers tend to offer additional share classes. It is essential to document the monitoring of available share classes in the search reports utilized in the fund selection process in case of a lawsuit. We also recommend that you consider developing a Fee Policy Statement that outlines your committee’s process for regularly reviewing available share classes. It is crucial to not only consider the individual investments you are offering but the aggregate portfolio as well.

Claim #4: Monitoring fund performance and taking appropriate action

The Claim: Institutions have been accused of imprudently retaining historically underperforming plan investments.

What ERISA Says: Once again, ERISA states the “prudent man” rule. Under this standard, plan fiduciaries should engage in a documented process to monitor designated investment options on an ongoing basis and replace underperforming funds. The documented process is critical because ERISA tends to be more concerned about process than outcome.

Best Practices: Fund monitoring should start with an Investment Policy Statement. Unless an institution knows how to monitor an investment, how will they know if the fund has performed adequately or not? Once policies and procedures are established, then regular, documented monitoring reports should be completed by an independent party (not the investment manager) and reviewed. Action should be taken in accordance with the provisions built into the Investment Policy Statement with respect to replacing underperforming funds. Remember, failure to act on perennially underperforming funds is no different than not monitoring funds in the first place.

Review Your Areas of Risk

The first step in protecting yourself against the above legal claims is reviewing your plan governance practices to see where you may be at risk. Things to consider:

  • What documentation do you have to defend potential claims?
  • When was the last time you reviewed record keeping fees and investment expenses?
  • Have you developed and are you following a process to review these items regularly?
  • Do you have the requisite experts on your staff to assist with this risk mitigation?

Many institutions find that their staff lacks the necessary expertise to mitigate the many risks they face. If you can relate, you don’t have to make major changes to your staffing. You can hire an expert retirement plan consulting firm that can share fiduciary status and lower your risk.

To learn more about how we at Beacon Pointe Advisors can help you protect yourself against common legal claims, call us at (949) 718-1600 or email us at info@bpadvisors.com.

Important Disclosure: This content is for informational purposes only. Opinions expressed herein are subject to change without notice. Beacon Pointe has exercised all reasonable professional care in preparing this information. Some information may have been obtained from third-party sources we believe to be reliable; however, Beacon Pointe has not independently verified, or attested to, the accuracy or authenticity of the information. Nothing contained herein should be construed or relied upon as investment, legal or tax advice. Only private legal counsel may recommend the application of this general information to any particular situation or prepare an instrument chosen to implement the design discussed herein. An investor should consult with their financial professional before making any investment decisions.

© Beacon Pointe Advisors. All Rights Reserved.


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